Understanding corporate value:

managing and reporting intellectual capital

 Intellectual capital Contents

1 Introduction 4

2 Definitions of intellectual capital 6

2.1 Classifications of intellectual capital
2.2 Why is intellectual capital so difficult to measure?

3 IC measurement 8
Generic models
3.1 Balanced scorecard
3.2 Performance prism
3.3 Knowledge assets map approach
Individual company models
3.4 The Skandia navigator
3.5 Ericsson’s cockpit communicator
3.6 Celemi’s intangible assets monitor
3.7 Ramboll’s holistic company model
3.8 Bates Gruppen CompanyIQ measurement system

IC valuation 14
3.9 The value-added approach
3.10 The value creation index
3.11 Market or value-based approach
3.12 Tobin’s q
3.13 Calculated intangible value
3.14 Matching assets to earnings – the Baruch Lev method
3.15 Human resource accounting
3.16 Value-added intellectual capital coefficient

4 Knowledge management 19
4.1 Knowledge process wheel
4.2 Knowledge management and the accounting profession

5 Reporting intellectual capital 23

5.1 Accounting standards
5.2 Operating and financial review
5.3 Intellectual capital reports

6 Conclusion 26

Writers: Danka Starovic, project manager, technical issues, CIMA, and

Bernard Marr, research fellow in the Centre for Business Performance at
Cranfield School of Management
Production editor: Sarah Vaux
Designer: Adrian Taylor
Publisher: Chartered Institute of Management Accountants
Inquiries: technical.services@cimaglobal.com (tel: 020 8849 2275)

3
Intellectual capital
1 Introduction
Knowledge being the new engine of
corporate development has become one
of the great clichés of recent years, but
there is no doubt that successful
companies tend to be those that
continually innovate, relying on new
technologies and the skills and
knowledge of their employees rather
than assets such as plants or machinery.
Value can be generated by intangibles
not always reflected in financial
statements and forward-looking
companies have realised that these are
an integral part of fully understanding
the performance of their business.
At the height of the dotcom boom,
companies with almost no assets in the
traditional sense of the word were
having their stocks more highly rated
than many of the stalwarts of British
and global industry. Much of the
discussion about intangibles thus grew
out of early attempts to account for the
sometimes staggering difference
between the so-called book and market
values of companies.
Since then we have had the US
company collapses, followed by a bear
market that continues to shrink the
value of equities around the world.
Intangibles still matter, but the key
driver for measuring and reporting
them has become transparency.
Investors – understandably wary
about the possibility of inflated
earnings after Enron or WorldCom – are
putting pressure on companies to report
all the value drivers of their
performance and that unavoidably
includes non-financial ones.
4
But it is not only investor pressure that
is forcing companies to accept that
managing intangibles is no longer an
optional extra. Forthcoming legislation
on issues such as the operating and
financial review, due to be included in
the Companies Act 2003, requires large
public and very large private companies
to provide a “qualitative as well as
financial evaluation of performance,
trends and intentions”. In other words,
companies will have to produce an
account of how their intangible assets
contribute to overall value generation.
This briefing is an attempt to raise
awareness of the need for companies of
all sizes to manage and communicate
the value of their business beyond that
captured by numbers alone. Some
companies, usually large, have already
implemented various intellectual capital
(IC) measurement tools and techniques.
The rest see themselves as being too
busy simply surviving to worry about
what seems like an unnecessary luxury.
Also included is a summary of some
of the current approaches and models
used for valuation and measurement. All
have limitations and many suffer from a
lack of practical testing. But this is still a
developing field, with contributions from
many disciplines, so the lack of
consensus is not surprising. More
experimentation and convergence in
terminology and tools will eventually be
necessary if the concept of intellectual
capital is to become widely accepted
and put into practice.
This is not an attempt to criticise or
devalue the traditional model of
financial reporting. Some intangibles
are already included on balance sheets;
others are not, for a reason. Traditional
reporting has served its purpose
well, but now forms only a part of
the jigsaw of how value is created
and communicated.
Intellectual capital and
accountants in business
In a recent KPMG survey of non-
executive directors (Neds), more than
60 per cent of the sample said they
didn’t consider themselves to be very
knowledgeable about non-financial
performance indicators. In fact, it came
last on the list of suggested topics. Not
surprisingly, financial performance was
at the top, with 94 per cent saying this
was an area where they were most
knowledgeable. As many Neds are
senior managers or executives
elsewhere, it is safe to assume this is
fairly representative.
It is not simply that directors are not
up to speed on intangibles, although
some of them may well not know much
about the subject. The main reason cited
for this worrying shortfall is that
“information provided by executives is
mainly financial”. Comments like this
clearly spell out the challenge ahead for
accountants. As the main custodians of
performance data in companies, they
need to ensure that the right
information is communicated to the

right people. Effective strategic and
operational decision-making hinges on
that information being relevant, timely
and robust – and that means it has to
consist of more than just numbers.
This briefing is therefore primarily
aimed at finance professionals and
accountants in business who would like
to implement or improve the
measurement and management of
intellectual capital in their own
organisations. It will also be useful to
anyone looking for a general
introduction and an overview of the key
concepts of intellectual capital and
knowledge management.
Why should you manage
intellectual capital?
Traditionally, the only intangible assets
recognised in financial reporting
statements were intellectual property,
such as patents and trademarks, and
acquired items such as goodwill.
Although it is still not possible to assign
monetary values to most internally
generated intangible assets, they
nevertheless need to be considered if
the process of value creation is to be
properly understood.
Failure to do so can have damaging
consequences at all levels. For an
individual firm, not understanding how
value is generated can lead to inefficient
resource allocation. It means the
company does not fully understand its
business model and may therefore be
unable to assess the value of future
business opportunities. On a wider scale,
it can lead to anomalous market
behaviour: if the markets don’t get the
information they need through “official”
channels they may resort to rumours
and speculation, which could lead to
volatility. There may also be a
misallocation of resources on a macro
level in terms of market investments.
Some go as far as to say that the lack
of understanding of intellectual capital
by market participants contributed to
some of the spectacular market failures
in the past few years (Holland, 2002).
Marconi in the UK and Enron in the US
are both examples of how rapid change
in the company value-creation processes
created systemic problems in the market
for information. In both cases, the
company value-creation processes
switched out of heavy use of tangibles
(Enron in physical energy production,
Marconi in electrical goods and defence)
Intellectual capital
into a perceived increased use of
intangibles (energy-trading skills,
provision of high-tech services). This
sudden switch may have contributed to
confusion among analysts and investors.
Companies that measure and report
intangibles may experience substantial
gains. For example, Leif Edvinsson,
former corporate director for intellectual
capital at Swedish financial services
company Skandia AFS, claims that a
reduction in the cost of capital of 1 per
cent was directly attributable to
the company’s ability to measure and
report its intangibles.
As long as it is relevant and timely,
additional information helps investors to
assess a company’s potential for future
earnings, so helping to keep share prices
stable. This in turn reduces the risks
associated with a company and results
in a lower cost of capital.
There can be little doubt that looking
beyond the assets reported in financial
statements should be a critical exercise
for every organisation wholly or partly
dependent on intangibles for its value
creation. Finance professionals should be
at the forefront of this process, using
their skills and expertise in measurement
and control to develop systems capable
of accommodating intellectual capital. ■
5
Intellectual capital
2 Definitions of intellectual capital
While there are plenty of generic
definitions of intellectual capital, many
organisations develop their own
idiosyncratic definitions. For example,
Skandia defines it as “the possession of
knowledge, applied experience,
organisational technology, customer
relationships and professional skills that
provide Skandia with a competitive edge
in the market”.
There is some confusion over how
intellectual capital differs from
intangibles, intangible assets or
intellectual property. This briefing will
follow the approach adopted by the
Meritum guidelines for managing and
reporting on intangibles and will use
intangibles and intellectual capital
interchangeably. There is no commonly
agreed definition of intangibles – the
word is often used as a noun to mean
broadly the same as intellectual capital.
Intangible assets, on the other hand, are
only those that financial standards
would recognise as assets and allow on
balance sheets.
Intellectual property can be defined as
intangible assets, such as patents,
trademarks and copyrights, that can be
included in traditional financial
statements. Measuring intellectual
property is important so an organisation
knows what it owns but it does not
‘Intellectual capital is the group of knowledge
assets that are attributed to an organisation
and most significantly contribute to an
improved competitive position of this
organisation by adding value to defined
key stakeholders’
6
capture the processes required to reach
that stage. Intellectual capital can be
both the end result of a knowledge
transformation process or the
knowledge that is transformed into
intellectual property.
1 Classifications of
intellectual capital
IC is a broad concept which is often
split into different categories – most
commonly human, relational and
structural capital.
According to guidelines produced by
researchers from universities across
Europe, collectively known as the
Meritum Project, human capital is
defined as the knowledge, skills and
experience that employees take with
them when they leave. Some of this
knowledge is unique to the individual;
some may be generic. Examples are
innovation capacity, creativity, know-
how and previous experience, teamwork
capacity, employee flexibility, tolerance
for ambiguity, motivation, satisfaction,
learning capacity, loyalty, formal training
and education.
Marr and Schiuma (2001)
Relational capital is defined as all
resources linked to the external
relationships of the firm – with
customers, suppliers or partners in
research and development. It comprises
that part of human and structural
capital involved with the company’s
relations with stakeholders (investors,
creditors, customers, suppliers), plus the
perceptions that they hold about the
company. Examples of this are image,
customer loyalty, customer satisfaction,
links with suppliers, commercial power,
negotiating capacity with financial
entities and environmental activities.
Structural capital is defined as the
knowledge that stays within the firm. It
comprises organisational routines,
procedures, systems, cultures and
databases. Examples are organisational
flexibility, a documentation service, the
existence of a knowledge centre, the
general use of information technologies
and organisational learning capacity.
Some of them may be legally protected
and become intellectual property rights,
legally owned by the firm under
separate title. The International
Federation of Accountants (IFAC) offers
a slightly different classification (see
table opposite).

2 Why is intellectual capital
so hard to measure?
The first reason is historical. Accounting
rules, although revised on a regular
basis, were initially designed for assets
such as plant or machinery – tangible
things that represented a source of
wealth during the industrial age. Second,
some intangibles are hard to measure.
Creativity, for example, is at the heart of
a knowledge-generation process yet is
essentially an unpredictable process
with unpredictable outcomes. It can
manifest itself in many ways. For
companies such as Sony and 3M,
product and process innovation play a
key role in market differentiation.
This leads us to the third problem: the
idiosyncratic nature of IC. What is
valuable for one company may be
worthless for another. This has resulted
in diverse measuring systems that make
comparability across companies and
sectors difficult.
Finally, intellectual capital can have
two dimensions. The Meritum guidelines
distinguish between intangible
resources and intangible activities as a
way of highlighting IC’s static or
dynamic character:
“The intangible resources of a
company, a static notion, can be
measured at any given time. Thus
worker competencies (human capital),
intellectual property rights (structural
capital), customer satisfaction or
agreements with suppliers (relational
capital) would be considered under
this category.
Intangible resources can also be
analysed in a dynamic sense. Companies
Classification of intellectual capital, IFAC (1998)
Human capital
● know-how
● education
● vocational qualification
● work-related knowledge
● occupational assessments
● psychometric assessments
● work-related competencies
● entrepreneurial elan,
innovativeness, proactive and
reactive abilities, changeability
Organisational (structural) capital
Intellectual property
● patents
● copyrights
● design rights
● trade secrets
● trademarks
● service marks
are undertaking activities to acquire or
internally produce intangible resources, to
sustain and improve existing ones and to
measure and monitor them. These
dynamic activities thus imply an allocation
and use of resources that are sometimes
not expressed in financial terms and,
consequently, may or may not appear in
the corporate financial reports.”
This dynamic nature of IC means that
its individual components are often not
Intellectual capital
Relational (customer) capital
● brands
● customers
● customer loyalty
● company names
● backlog orders
● distribution channels
● business collaborations
● licensing agreements
● favourable contracts
● franchising agreements
Infrastructure assets
● management philosophy
● corporate culture
● management processes
● information systems
● networking systems
● financial relations
valuable by themselves but work only as
a system. In other words, it is the
intellectual capital elements interacting
that generates value for companies. For
example, a company may have good
programming skills that enable it to
build software. However, they might be
worth little unless accompanied by a
strong distribution network, loyalty and
commitment from its employees and a
powerful brand name. This dynamic
combination of intangibles is often the
recipe for success in companies such as
Microsoft, where the value of its
intellectual capital is more than the sum
of its individual parts. ■
7
Intellectual capital

3 IC measurement and valuation

Performance management and IC measurement ● customer measures: how do our

valuation frameworks have traditionally Generic models customers see us, for example, price
paid little attention to assessing as compared with competitors and
knowledge, concentrating almost 1 Balanced scorecard product ratings;
exclusively on financial results. In 1992, Robert Kaplan and David ● internal process measures: what must
When influential authors such as Norton pioneered their balanced we excel at, for example, length of
Kaplan and Johnson argued during the scorecard (BSC). Since then, it has cycle times and level of waste;
1980s that the finance-dominated become a model for many of the ● learning and growth measures: can
performance-management systems were reporting systems that include non- we improve and create value, for
failing to meet the needs of modern financial measures. example, percentage of sales derived
companies, a number of seemingly more Over the past decade, the balanced from new products.
comprehensive approaches, such as the scorecard has evolved from being a Today, Kaplan and Norton stress the
Smart pyramid or performance measurement framework to being a importance of visualising causal
measurement matrix, were proposed. strategy implementation tool. It relationships of measures and objectives
Although these represented a step in represents a set of cause-and-effect in so-called strategy maps. These are
the right direction, they fell short of relationships among output essentially communication tools that
explicitly addressing the issue of IC. measures and performance drivers in visualise an organisation’s strategy and
The total quality management (TQM) the four perspectives: the processes and systems needed to
movement with its associated initiatives, ● financial measures: how do we look to implement it.
such as the EQFM excellence model or shareholders, for example, cash flow Although Kaplan and Norton insisted
the Malcolm Baldridge award, and profitability; that companies should select their own
encouraged organisations to examine measures, many have criticised the BSC
the “softer” dimensions of their model for being too limited. For
performance such as leadership,
employees and impact on society. Figure 1: performance prism
Business results – expressed in financial
terms – still mattered but were to be
considered in a wider context of
interaction with various stakeholders. Stake
holde
However, TQM was primarily r satis
factio
developed as a philosophy of business n
behaviour and has limited use in Investors
performance measurement. Customers and
intermediaries
Since then there has been a Employees
proliferation of models, none of which Regulators and
communities
has been put into widespread use Suppliers
except the balanced scorecard. Stake
holde
Measurement approaches r con
tribu
tion
(outlined below) are mainly about how
companies measure and report
performance internally in order to gain
management insights that can help
them to run their business. Valuation Strat Proce Capa
egies sses bilitie
s
approaches, on the other hand, are
primarily concerned with placing an
economic value on firms and their
intangibles. They generally take an ● Develop products and ● People
● Corporate
external view and are designed to help ● Business unit services ● Practices
analysts or investors assess the financial ● Brands/products/ ● Generate demand ● Technology
value of an organisation. services ● Fulfil demand ● Infrastructure
● Operating ● Plan and manage enterprise

8

example, the perspectives fail to address
the needs of all an organisation’s
stakeholders and the execution may be
too driven from the top for it to be
effective. It has also been said that some
of the relationships between the four
perspectives are more logical than
causal. PricewaterhouseCoopers, in the
recent book Building Public Trust, has
disclosed the findings of an unpublished
survey in which 69 per cent of
executives reported “that they had
attempted to demonstrate empirical
cause-and-effect relationship between
different categories of value drivers and
both value creation and future financial
results. Less than one-third of these felt
they had truly completed the task; this
suggests its difficulty”.
2 Performance prism
The performance prism (see figure 1) is
a second-generation performance
measurement and management
approach developed by Cranfield School
of Management in collaboration with
consultancy Accenture.
It recognises the importance of
companies taking a holistic approach to
stakeholder management in today’s
culture of involvement. Its advantages
are that it addresses all stakeholders –
not only investors but customers and
intermediaries, employees, suppliers,
regulators and communities. It does this
in two ways: by considering the
requirements of those stakeholders and,
uniquely, what the organisation wants
and needs from its stakeholders. In this
way, the reciprocal relationship and the
exchange process with each stakeholder
is examined. The performance prism
addresses the strategies, processes and,
importantly, the capabilities that are
needed to satisfy these two critical sets
of wants and needs.
The flexibility of the performance
prism allows it to be applied to any
organisation or organisational
component. The focus on intangible
performance drivers makes the
Figure 2: hierarchy of knowledge assets
Knowledge
asset
Stakeholder
resources
Stakeholder Human Physical
relationship resources infrastructure
Culture
framework useful for companies
attempting to measure their intellectual
capital. Also, it creates a visual map of
how the different areas of performance
interrelate. It explicitly acknowledges
that all five facets of the performance
prism should be covered in a so-called
success map. This way, it avoids the
often-criticised narrowness of the
balanced scorecard.
A more detailed description of the
performance prism model can be found
in CIMA’s technical briefing, “Latest
trends in corporate performance
measurement” at www.cimaglobal.com/
downloads/tech_brief_perf_man_160702
.pdf. CIMA will soon publish an
executive guide on performance
reporting to boards which will include a
case study showing how Shell
implemented the performance prism.
3 Knowledge assets
map approach
The knowledge assets approach takes a
knowledge-based view of a firm. It was
specifically designed to help companies
identify and measure their knowledge-
Intellectual capital
Structural
resources
Virtual
infrastructure
Routine and Intellectual
practices property
based assets and their contribution to
value. Having identified the critical
knowledge assets, they can easily be
integrated into broader frameworks
such as the performance prism.
Knowledge assets are identified as the
sum of two organisational resources:
stakeholder and structural. This
distinction reflects the two key
components of any enterprise: its
actors, who can be internal or external,
and its constituent parts, or the
elements at the basis of an
organisation’s processes (see figure 2).
Stakeholder resources are divided into
stakeholder relationships and human
resources – the external and internal
actors of a company. Structural
resources are split into physical and
virtual infrastructure, which refers to
their tangible and intangible nature.
Finally, the virtual infrastructure is
further divided into culture, routines and
practices, and intellectual property.
Stakeholder relationships include all
forms of relationships established by the
company with its stakeholders. These
relationships could be licensing
agreements, financial relationships, or
contracts and arrangements about
distribution channels. It could also be
9
Intellectual capital IC measurement and valuation
customer loyalty, which represents a
fundamental link between the company
and one of its key stakeholders.
Human resources contains
knowledge provided by employees in
forms of competencies, commitment,
motivation and loyalty as well as
advice. Key components are also
know-how, technical expertise, problem-
solving capacity, creativity, education
and attitude.
Physical infrastructure comprises
all infrastructure assets, such as
structural layout and IT equipment such
as computers, servers and physical
networks. This category is often
overlooked as a knowledge asset
but plays a key role in how knowledge
is shared.
Culture embraces corporate culture
and management philosophies. Some
important components are the
organisation’s values, mission and vision.
Culture is of fundamental importance
for organisational effectiveness and
efficiency, since it provides a framework,
sometimes implied, through which to
interpret events.
Routines and practices cover
internal practices and virtual networks
and routines. These routines could
include tacit rules and procedures, such
as manuals with codified procedures and
rules, databases and tacit rules of
behaviour or management style.
They determine how processes are
handled and how work flows through
the organisation.
Intellectual property is the sum of
patents, copyrights, trademarks, brands,
registered designs, trade secrets and
processes whose ownership is granted
to the company by law. These are the
tools and enablers that allow the
company to perform its daily processes
to produce results.
This framework can be used to help
identify knowledge assets, which can
10
Figure 3: value creation map
Stakeholder
relationships
Human resource
Practices and
routines
Intellectual
property
then be the basis for visualisation of
how these assets are interrelated and
transformed to satisfy stakeholder
needs. Such a visualisation is called a
value creation map (see figure 3) and it
shows the pathways of how value is
created in organisations. Knowledge
assets are represented in bubbles linked
with arrows. The size of individual
bubbles represents stocks of particular
knowledge assets in terms of strategic
importance and arrows of different
thickness show the transformations and
relationships between knowledge assets
and stakeholder needs (based on a
concept by G Roos (1997)). A map can
be used to visualise the static and
dynamic nature of IC and how it adds
value to different stakeholders.
It is possible to provide a wide range
of indicators for each of the categories
listed: it is up to the management team
to identify the most meaningful ones.
Care needs to be taken when
selecting the metrics. Many of those
proposed in accounting literature tend
(source: Marr 2003)
Culture
Physical
infrastructure
Financial
success
to be general and fail to address the
types of knowledge that play a critical
role in value delivery for individual
companies. Managers need to start by
recognising that knowledge assets are
unique to each company and the
metrics selected should therefore reflect
this (see figure 4).
Individual company models
Some companies, notably from
Scandinavia, have developed their
own measurement models. It should
be pointed out that all those
mentioned derive at least a part of their
income from consultancy and therefore
have a commercial interest in promoting
their models. Elsewhere the
development and use of IC models is
patchy. Mainland Europe is probably the
least advanced, with the UK and US a
little further ahead. Pacific Rim
countries such as Australia and Japan,
on the other hand, have recently made
strong advances.
4 Skandia navigator
Of all the systems for measuring IC
Skandia’s navigator model, developed in
1994, is probably the best known, even
though it is only implemented in the
Swedish part of the organisation.
 Intellectual capital

Figure 4: knowledge assets indicators

Stakeholder relationships ● Number/quality of partnering agreements; number/quality of distribution agreements;

number/quality of licensing agreements; public opinion survey; market share; length of
relationship; partner satisfaction index; customer retention.
Human resources ● Demographics indicators, for example, number of employees; number of employees in alliances;
average years of service with company; average age of employees; full-time permanent employees
as percentage of total employment; employees working at home/total employees; number of
women managers.
● Competence indicators, for example, employees with high qualifications; people with PhD and/or
masters degree/total employees; average years of service with the company; number of years in
specific professions; definition of a competence map.
● Attitude indicators, for example, average level of happiness (measured with Likert-type scale);
savings from implemented suggestions from employees; number of new solutions, products and
processes suggested; qualitative descriptions of employees (commitment, loyalty, entrepreneurial
spirit, enthusiasm); motivation and behaviour indicators.
● Human resource management practices indicators, for example, training expenses/employees;
employee turnover; time in training; expenses for employee-development activities (social and
personal); indicators about activities to motivate employees; indicators about recruitment practices.
Physical infrastructure ● Scalability/capacity measures; facilities/equipment versus plan; time to execute server updates;
system integration; use of knowledge-sharing facilities.
Culture ● Management philosophy; number of internal disputes and complaints; qualitative measures
about employee satisfaction; feedback; values; behaviour; motivation; commitment; loyalty;
opinion survey.
Practices and routines ● Process quality; number of codified processes; networking practices; norms; database availability;
intranet use.
Intellectual property ● Revenues from patents; number of patents and registered designs; value of copyrights; value of
patents versus R&D spend; trademarks; brand recognition survey.

It reflects four key dimensions of its

business: financial focus; customer
Figure 5: Skandia navigator (source: L Edvinsson and M S Malone, 1997)
focus; process focus; and renewal and
development focus. At the heart of
these is human focus, which drives the History
whole model.


Financial focus
The similarity with the balanced
scorecard is immediately apparent.
Indeed, Sveiby (1998) sees the navigator
as a combination of the BSC and Today
Celemi’s intangible assets monitor.
Edvinsson says that navigator can be Human
Customer focus Process focus
“viewed as a house. The financial focus focus
is the roof. The customer focus and IC
process focus are the walls. The human
focus is the soul of the house. The Tomorrow
renewal and development focus is the
platform. With such a metaphor,
Renewal and development focus
renewal and development become the
critical bottom line for sustainability.”
(See figure 5.) Operating environment

11
Intellectual capital IC measurement and valuation

Each of the five focuses has critical

success factors that are quantified to
Figure 6: Celemi’s intangible assets monitor (Karl-Erik Sveiby)
measure change. The indicators used for
the financial focus are largely Our customers Our structure Our people
represented in monetary terms. (external structure) (internal structure) (competence)
Customer focus concentrates on
Growth/renewal Growth/renewal Growth/renewal
assessing the value of customer capital
Revenue growth Organisation-enhancing Average
to the organisation and makes use of
customers professional
both financial and non-financial competence years
indicators. The measures used for the Image-enhancing customers Revenues from new Competence-
process focus emphasise the effective products enhancing
use of technology within the customers
organisation. They tend to monitor R&D revenues Growth in
quality processes and quality professional
management systems but also include competence
some financial ratios. Intangible investments Experts with post-
(% value added) secondary degree
The renewal and development focus
attempts to capture the innovative
Efficiency Efficiency Efficiency
capabilities of the organisation, Revenues per customer Proportion of Value added per
measuring the effectiveness of its admin staff expert
investment in training and its Revenues per Value added per
expenditure on R&D. Finally, the human admin staff employee
focus includes measurements that reflect
the human capital of the organisation Stability Stability Stability
and how the resources are being Customer satisfaction index Admin staff turnover People satisfaction
enhanced and developed. index
Repeat orders Admin staff seniority Median age of all
Measurements from the five focuses can
(years) employees (years)
then be recorded and compared from
Five largest customers Rookie ratio Expert seniority
year to year. (years)
Expert turnover
5 Ericsson’s cockpit
communicator (source: “Uncovering Hidden Assets”, Celemi Annual Report, 1999)
Ericsson, the Swedish
telecommunications company, has
developed a commercial product called that are compatible with the 6 Celemi’s intangible
the cockpit communicator, again based company’s strategies; assets monitor
on the balanced scorecard and with five ● a communicated strategy linked to International training consultancy Celemi
very similar perspectives: innovation, indicators and actions; monitors three overall categories:
employee, process, customer and ● a balanced focus on past, present and customers (external structure); people
financial. Each is represented as the dials future performance; (competence); and organisation (internal
in an aircraft cockpit and each has its ● a balance between short-term results structure). Under each of these
own indicators. Following inputs and long-term strategy; interdependent categories, the three key
relevant to each indicator, the ● the ability to evaluate and change areas of growth/renewal, efficiency and
communicator suggests the actions that organisational strategy rapidly in line stability are tracked, each with its own
will match the organisation’s strategies. with performance and changing performance indicators (see figure 6).
The dials will subsequently show if the business conditions; Celemi also produces a management
company is on target in each ● the ability to manage, measure and training game called Tango which
perspective. According to Ericsson, the communicate future values. uses intangible assets monitor thinking
aims of this product are: and accounting.
● a vision-driven organisation,
where priority is given to actions

12

7 Ramboll’s holistic
company model
As with other Nordic models,
Ramboll’s holistic company model
(see figure 7) consists of key areas
within which certain performance
indicators are managed.
These key areas lead to three sets of
results – customer, employee and
societal – and all three combine to
produce the financial results. The
key areas are values and
management, strategic processes,
human resources, structural resources
and consulting services.
For example, the performance
indicators for human resources are
staff composition, staff turnover and
competence building.
These key performance indicators
(KPIs) are then further subdivided.
The ones for competence building,
for example, are supplementary
training expenses excluding salary,
the amount spent per course
participant and the hours off
contributed by employees.
The table (see figure 8) provides a
list of possible human, organisational
and customer capital indicators,
but measurements will always be
company-specific.
Figure 7: Ramboll’s holistic company model
Human
resources
Values and Strategic
Consultancy
management processes
Structural
resources
8 Bates Gruppen
CompanyIQ measurement
system
Bates Gruppen is the Norwegian arm of
Bates Worldwide and part of the
Cordiant Communications Group. It has
recently proposed a method that
consists entirely of non-financial
measures. The CompanyIQ allows a
company to score its knowledge assets
against those of a similar organisation.
● Stage one
Identify why customers buy from your
company as opposed to a rival. This is
best done in a day workshop in which
management select between eight
and 12 attributes – for example, rapid
response or good design. The final list
is sent to customers and employees
who rate each attribute twice, once
for its value to customers and then for
its uniqueness. A scale of one to
seven is used. The results are plotted
on to a two-by-two matrix. Any
attributes that make it into the top
upper-right quadrant – ie are high on
value and uniqueness – will be
explored further.
● Stage two
Identify the intellectual assets that
produce star attributes – Bates
Gruppen has identified 100. Ideally,
Customer
results
Employee
Financial
results
Societal
results
Intellectual capital
these should be divided as equally as
possible between human, customer
and structural IC assets. All of these
assets must either be measurable in
absolute terms, for example, training
expenses, or capable of measurement
using scales, for example, customer
satisfaction. At least 60 per cent of
the assets identified should be
comparable to data from reputable
benchmarking studies or from the
PIMS database – a huge repository
containing data on items such as
quality for thousands of companies.
● Stage three
It is now possible to calculate your
CompanyIQ. Scores on the 100
selected assets must first be weighted
for relative impact on profitability
(available from PIMS) then compared
with similar companies on the chosen
database. Bates Gruppen has selected
a median score of 100.
The process does not stop at stage
three. As with any measurement system
some form of feedback has to be built
into the system for a company to remain
competitive. The strength of assets
within the 100 can be identified and
weaker ones improved.
This method is more than just a
measurement system. It requires an
organisation to identify its highly
valuable, unique capabilities and the
intellectual capital assets behind them.
While calculating its IQ, a company
may find it is producing goods or
providing services that are similar to
those of a competitor or contain
features that add little value to
customers. This will leave the
company with a ready-made list of
indicators, so allowing it to take action
that has a direct impact on its profit-
maximising capabilities.
This system requires a great deal of
work initially, including gathering data
from employees and customers who may
be unwilling to participate or who may
provide hastily compiled information of
13
Intellectual capital IC measurement and valuation

Figure 8: Ramboll’s holistic company model list of indicators

Human capital indicators Organisational capital indicators Customer capital indicators

Revenue generated per employee Income per R&D expense Growth in sales volume
Number of senior positions filled Individual computer links to database Revenues per customer
by junior staff
Recruitment, development and Number of times database has Proportion of sales to repeat
training spend per employee been consulted customers
Employee satisfaction Upgrades of database Customer satisfaction
Average length of service of staff Contributions to database Effectiveness of ad campaign
Staff turnover Upgrades of SOPs Brand loyalty
Educational level of staff Value of new ideas Brand image
Staff with professional qualifications Ratio of new ideas generated to new Product returns as a
ideas implemented proportion of sales
New ideas generated by staff Number of new product introductions Customer complaints
Value added per employee New product introductions per employee Reputation of company
Post-training evaluation exercise – Proportion of income from new Proportion of customer’s business
benefits accrued product introductions that your product or service
represents
Proportion of revenue-generating Number of patents
staff to other
Image of company from employee’s Average length of time for product design
perspective and development
Changes implemented due to employee
or customer satisfaction surveys
IT expenditure as a percentage of
administration spend

All of the above indicators are either numerical or can be represented numerically, for example, company image can be rated from 1, for poor, to
10, for excellent. Therefore indicators provide figures that can be compared from year to year. Where the indicators give a financial figure they
represent a link between the non-financial and financial dimensions. For example, the innovative capabilities of staff (new ideas) can be measured
by assessing the value of new ideas to the organisation (money saved or money earned). Skandia Banken (part of the Skandia Group) makes an
interesting measure – an expense ratio that compares the cost of knowledge transfer to overall operating expense (Lynn, 1998). The key is in
identifying appropriate measurement techniques and indicators that show how value has been created.

little use. It may also be difficult for a
company to divide its knowledge assets
equally between the three types of
intellectual capital, meaning that some
are incorporated to make up the
numbers while others are excluded. The
suggestion that at least 60 per cent of
the indicators are comparable to those
from other companies still leaves a lot
open to subjectivity.
Valuation of IC
Valuation approaches were developed to
allow external parties or stakeholders to
put an economic value on an
organisation. They are usually based on
publicly available data and are mostly
used by finance professionals.
It is a challenging area and it is
difficult to see how some of the models
can be meaningfully applied in practice
in their current state.
9 Value added approach
This measurement and valuation
technique was proposed by Robinson
and Kleiner (1996) and comprises a
framework of two parts.
The first part uses Porter’s value chain
concept. The basic premise, from an
industrial perspective, is that raw
materials enter from one end of the
chain and, as they go through the
processes that will eventually convert
them into finished goods, value is added
to them. Production is not the only
function involved as the raw materials
have to be procured and the finished
goods marketed and sold.
The whole procedure also has to be
administered and managed. The key
point is that all of these internal
functions should serve the overall
purpose of the organisation, which is to
create value for its customers.

14

The second part of the framework is
borrowed from the economic value
added (EVA) theory, which has its roots
in corporate finance and was developed
by Stern Stewart, a New York-based
consultancy. If the return on capital for
any project is greater than the cost of
capital then the company should
proceed with it. The basic objective of
EVA is to develop a performance
measure that accounts for all the ways
in which organisational value can be
added or lost.
Robinson and Kleiner proposed
combining Porter’s concept and EVA so
that the “financial project evaluation
approach, which relies on value creation,
should be applied to all of the internal
processes of the value chain. The
unfortunate difficulty is that many of the
internal processes are in the form of
intellectual capital and are not readily
measurable.” To overcome this barrier
Robinson and Kleiner have come up
with several suggestions, including:
● measuring intellectual property
(patents, licences) at their current
market value;
● using the Hay method (named after
the Hay Group, a global personnel
consultancy) to measure human
capital, whereby job categories and
their related salaries are evaluated by
measuring know-how, problem-
solving and accountability;
● the use of ratios such as training per
employee, number of ideas per
employee and other productivity/
employee ratios;
● measuring the ability of an
organisation to learn and adapt to
changes in the environment.
Porter’s value chain concept and EVA
are both well established and combining
them to assess how key activities create
value within an organisation has clear
benefits. It should eliminate any
wasteful activities and lead to the
maximum amount of value being added
to a product or service.
The difficulty arises when it comes to
the measurement of value, especially
when the activity is “soft”. Clearly the
prompt answering of a customer query
adds value, but it would be difficult to
put a monetary value on it. Robinson’s
and Kleiner’s suggestions to overcome
this fall short of providing clear
valuations for all “soft” assets, so their
proposal should be seen as more of a
framework to be used if and when a
reliable method of measuring intellectual
capital is agreed.
10 Value creation index
The value creation index attempts to
measure the importance of different
non-financial metrics in explaining the
market value of companies.
It followed a survey of readers of
Forbes ASAP, the technology
supplement of US business journal
Forbes, in which they were asked to
rank the key drivers of corporate value
in their industries. Publicly available
information was then used to develop a
series of metrics associated with those
value drivers and the correlation
between the metrics and share prices
was tested. The aim was to discover
what factors the market considers
important rather than just what
managers say is important.
The survey revealed the following
key findings:
Intellectual capital
● Key drivers of corporate value (in
rank order):
1 Customer satisfaction.
2 Ability to attract talented employees.
3 Innovation.
4 Brand investment.
5 Technology.
6 Alliances.
7 Quality of major processes, products
or services.
8 Environmental performance.
The authors compared these findings
with those of their own research.
● Key drivers of corporate value in
durable manufacturing (in rank order):
1 Innovation.
2 Ability to attract talented employees.
3 Alliances.
4 Quality of major processes, products
or services.
5 Environmental performance.
6 Brand investment.
7 Technology.
8 Customer satisfaction.
This kind of rigorous analysis,
especially the attempt to correlate
metrics with capital markets, is in stark
contrast to simpler measurement
techniques. However, the statistical and
data-gathering techniques required are
daunting and few corporate teams have
the time, skill or inclination to incur the
necessary costs. Nevertheless, it offers
two important insights:
● What management (and perhaps
users) consider important may not
coincide with marketplace behaviour.
15
Intellectual capital IC measurement and valuation
For example, customer satisfaction
does not have the impact in the
marketplace that managers tend to
assume it has.
● The value creation index attempts to
develop different indices for different
industries. This is consistent with
the view now widely held in IC
circles that non-financial
performance metrics must be
company- or industry-specific.
Details of another market-driven
reporting framework, developed by
PricewaterhouseCoopers, can be found
in CIMA’s executive briefing “Business
Transparency in a Post-Enron World”.
ValueReporting was developed
specifically to try and close the gap
between what companies currently
report and what the markets want. It is
based on extensive research in the
capital markets and tailored to match
the performance dimensions of specific
industries. Go to www.cimaglobal.com/
downloads/enron.pdf
11 Market or value-based
approach
A simple way of calculating the value of
an organisation’s intellectual capital is to
take the difference between its market
value – the number of shares in issue
multiplied by the market value of the
share – and the net value of its assets.
This can be done with a minimum of
information and the gap between the
two figures, the market-to-book ratio, is
often used as an indication that a
company has many intellectual capital
assets that are not reflected in its
financial statements.
There are several drawbacks to this
method. The most obvious flaw is that
this method values IC as one asset and
makes no attempt to separate the items
that might comprise it.
16
In addition, the market value of a
company is subject to a number of
external variables, including
deregulation, media and political
influences and rumours. You only have
to look at the overvaluation of some of
the earliest dotcoms to go public and
the subsequent dramatic drop in their
share values. In the case of
lastminute.com, the share price fell by
90 per cent in less than 18 months, yet
there was little change in the company’s
intellectual assets.
The current financial accounting
model also does not attempt to value
the firm in its entirety. Instead, it records
each of its severable assets at an
amount in accordance with current
legislation and the financial accounting
standards. The market, however,
would value the company in its
entirety as a going concern. This
means the figure for intellectual capital
would differ simply by the adoption of
different accounting policies across
national boundaries.
12 Tobin’s q
The “q” developed by economist
James Tobin stands for the ratio of the
market value of the firm to the
replacement cost of its assets. If the
latter is lower than the former, then
the company is making a higher than
normal return on its investment.
Technology and human capital
assets were traditionally associated with
high q values.
It could be argued that Tobin’s q is
more accurate than the market-to-book
method because it uses replacement,
rather than historic, costs. However,
finding these replacement costs is more
difficult than simply referring to a
balance sheet. The model is also subject
to the same drawbacks as previous
ones, since it uses the market value as
one of its key measures.
Tobin’s q cannot provide an accurate
figure for individual intellectual assets.
Its real value lies in trend analysis: if the
q is falling, either the company is not
managing its intellectual assets
effectively or investor sentiment has
moved against it.
13 Calculated intangible
value
Calculated intangible value (CIV) is
similar to the super-profits method of
valuing a company – the difference
between the maintainable profit and the
expected return on the tangible assets
employed. Stewart (1995) illustrates the
method by using data from US
pharmaceutical company Merck:
● Stage one
Calculate average pre-tax earnings for
three years – $3.694 billion.
● Stage two
Go to the balance sheet and get the
average year-end tangible assets for
three years – $12.953 billion.
● Stage three
Divide earnings by assets to get the
return on assets (ROA) – 29 per cent.
● Stage four
For the same three years, find the
industry’s average ROA. For
pharmaceuticals the average is 10 per
cent (this method will not work if the
ROA is below average).

● Stage five
Calculate the “excess return”.
Multiply the industry average ROA by
the company’s average tangible assets
– 10 per cent x $12.953 billion. This is
what the average drug company
would earn from that amount of
tangible assets. Subtract that from
the company’s pre-tax earnings,
which in the case of Merck would
give an excess of $2.39 billion. This
is how much more that company
earns from its assets than the average
drug manufacturer.
● Stage six
Calculate the three-year-average
income tax rate and multiply this by
the excess return. Subtract the result
from the excess return to get an after-
tax figure. This is the premium
attributable to intangible assets. For
Merck, with an average tax rate of
31 per cent, this is $1.65 billion.
● Stage seven
Calculate the net present value (NPV)
of the premium. This is done by
dividing the premium by an
appropriate percentage, such as the
company’s cost of capital. Using an
arbitrarily chosen 15 per cent rate,
this yields Merck $11 billion. This is
the CIV of Merck’s intangible assets.
This final figure is not the amount left
were you to subtract the tangible assets
from the market value of Merck, which
at the time of calculation would have
been $45.6 billion. Rather, the
$11 billion reflects a measure of the
company’s ability to use its intangible
assets to outperform other companies in
its industry. A rising CIV indicates that a
business is generating the capacity to
produce future wealth – even if the
market hasn’t recognised it yet. A weak
or falling CIV may point to the fact that
a company’s investments in intangibles
aren’t paying off or that too much is still
being spent on tangible fixed assets.
A major benefit of CIV is that it allows
inter- and intra-industry comparisons on
the basis of audited financial results. As
with other methods that provide ratios,
there is also the potential for setting
benchmarks and spotting trends.
But there are problems. First, it adopts
the industry ROA as a basis for
determining excess returns and, as
averages tend to suffer from outlier
problems, there could be excessively
high or low ROAs. Second, the
company’s cost of capital will determine
the NPV of intangible assets. Calculating
the industry average to counter this will
result in the same problems as the
adoption of an average industry ROA. It
is also impossible to separate IC from
goodwill using the resulting value, so
the method fails to evaluate the
individual components of IC.
14 Matching assets to
earnings – the Baruch
Lev method
Baruch Lev, professor at Stern School of
Business, New York University, has
proposed a method of matching
earnings with assets that generate them.
The calculation uses expected after-tax
returns on assets – two are averages
and one (for IC assets) is formulated
using correlations between return on
equity and cash flow, traditional
earnings or knowledge earnings.
● Stage one
Take average annual earnings for a
company. Lev suggests using three
years of past earnings and three
Intellectual capital
years of earnings provided by the
consensus forecasts of analysts. For
the sake of this example, assume they
are $1 billion.
● Stage two
See what the balance sheet has in the
way of financial assets. Assume they
are $5 billion. Then take the expected
after-tax return on financial assets,
which is approximately 4.5 per cent.
Therefore the $5 billion worth of
financial assets explains $225 million
of the earnings.
● Stage three
Now turn to the physical assets of the
company and again assume they are
worth $5 billion. Using the average
after-tax return for physical assets,
which is approximately 7 per cent,
$350 million of earnings can be
credited to them.
● Stage four
This leaves a balance of $425 million
that must have been produced by
assets not on the balance sheet,
which Lev calls knowledge-capital
earnings. These earnings are then
divided by an expected rate of return
on knowledge assets, which has been
worked out at 10.5 per cent (see
notes below).
● Stage five
Using the formula:
Knowledge capital earnings
Knowledge capital discount rate
it can now be assessed that, to
produce $425 million in earnings, this
imaginary company would need
$4.06 billion of intangible assets.
In order to calculate the intellectual
asset discount rate, Lev looked at
17
Intellectual capital IC measurement and valuation
whether cash flow, traditional earnings
or knowledge earnings most correlates
with return on equity. He found only a
0.11 correlation between strong returns
on equity and cash flows, a 0.29
correlation with traditional earnings and
a strong 0.53 correlation with
knowledge earnings. This would seem
to justify a rate of 10.5 per cent that
compares with 4.5 per cent for financial
assets and 7 per cent for physical assets.
Like CIV, Baruch Lev’s method uses
both earnings and assets as data sources
rather than relying purely on assets. By
matching assets to earnings,
organisations would be left with a figure
they can use for comparisons with other
companies, or for indicating that their
own earnings from IC are going up or
down. However, like some of the other
methods, this one results in a single
figure for IC while not attaching values
to individual components. The figure
of 10.5 per cent representing the
expected rate of return on knowledge
assets could be challenged. The
method has also been criticised as being
too complex.
15 Human resource
accounting (HRA)
The aim of human resource accounting
(HRA) is not simply to describe the
financial accounting aspect of
capitalising expenditure on recruitment,
18
training and development. It is also
designed to quantify the economic value
of people to the organisation in order to
contribute to decision-making, planning
and control processes.
As a result, various models have been
proposed, all with the underlying
rationale of attempting to calculate the
contribution each employee makes to
the organisation.
According to Bontis et al (1999), HRA
can provide external information to
accounts users but also has other
associated benefits. It allows for internal
feedback to the members of the
organisation on the accomplishment of
strategic goals. It also acts as a starting
point to develop future plans and
strategies by recognising the core
competencies inherent in a company’s
unique IC.
However, HRA again relies on human
capital alone and, although salaries,
wages and the costs of recruitment and
training are simple enough to measure,
putting value on the growth and
accumulation of employee knowledge
can prove a lot more difficult.
16 Value-added intellectual
capital coefficient
This method calculates the difference
between sales and all inputs (except
labour expenses), divided by intellectual
capital, which is estimated by total
labour expenses. The higher the ratio,
the more efficient the company is at
using IC assets.
The main advantage of this approach
is simplicity. The figures are easy to
obtain from any annual report and, once
calculated for a year, can be used for
inter- or intra-company comparisons.
However, this straightforwardness has
many disadvantages. Comparing an
organisation’s labour expenses to its IC
would appear to undervalue IC when
compared with other methods such as
the market-based approach. Also, a
company could be using its labour
resources inefficiently, but this could be
masked by a more efficient use of other
inputs leading to a similar ratio.
The approaches outlined give a good
idea of the range of methods, disciplines
and functional specialisms employed in
measuring and valuing intellectual
capital. Only one of these – the
balanced scorecard – is in widespread
use, while the rest remain too
theoretical, too flawed or simply too
undeveloped to be accepted universally.
Eventually, it may be a combination of
these ideas that provides the most
practical solution. ■
This section is based on two CIMA-
sponsored research projects, “Measuring
the immeasurable” by Wall, Kirk and
Martin of the University of Ulster, and
“Measuring and managing knowledge”
by Marr, Neely and Schiuma of Cranfield
School of Management.

4 Knowledge management
Intellectual capital and knowledge
management (KM) should not be
confused. It is essential for all companies
to maintain and grow their IC stocks –
rather than simply measure them – and
knowledge management is one way
of helping them to do this. But the
two are quite distinct: KM is a process
within a company, whereas IC covers its
whole operations.
As with many of the concepts in this
area, there is no universal definition of
knowledge management. The Gartner
Group defines it as “a discipline that
promotes an integrated approach to
identifying, managing and sharing all of
an enterprise’s information assets. These
information assets may include
databases, documents, policies and
procedures, as well as previously
inarticulated expertise and experience
resident in individual workers.
KPMG came up with a more
commonly used definition in 2001:
“Knowledge management is a collective
phrase for a group of processes and
practices used by organisations to
increase their value by improving the
effectiveness of the generation and
application of intellectual capital.”
The term “knowledge worker” was
first used by management guru Peter
Drucker in the 1960s. He rightly
predicted that knowledge would
become the key economic resource
and even called knowledge workers the
new capitalists.
But it wasn’t until the late 1990s that
the craze for all things knowledge
management really began. Traditional
competitive advantage based on
economies of scale was eroded by
smaller, nimbler and more ingenious
competitors. As the market cap of start-
ups soared, companies around the world
suspected that their potential for success
may reside in the knowledge, expertise
and creativity of their employees.
Intellectual capital
Yet few knew how to use this as a one-off initiative or purchase with
knowledge in a systematic way in an expensive piece of software.
order to gain real business benefits. The misconception that there was a
This created a huge demand for finite stock of knowledge to be
products and services about “managed”, almost always with an
knowledge management – books, expensive IT system, meant that many
conferences and consultancies were companies initially overlooked the
suddenly everywhere. overall business purpose. In fact, many
After the boom came the bust and embarked on knowledge-management
much of the market cap created in the initiatives without a clear idea of what
late 1990s had been wiped out even business benefits they could expect and
before Enron and the geopolitical what else might have to be changed to
developments sent the world stock make them work.
markets into turmoil. But knowledge Instead, companies should start off
management remains an important with a clear value proposition that is
concept in an economy dominated by then driven through every part of the
intangibles and there are now signs that system, including organisational culture.
it is becoming a part of everyday It has been said that you can’t
business infrastructure. Rescued from manage knowledge; you can manage
being a consultant-driven fad, it is no only the culture that leads to that
longer seen as an end it itself – knowledge being shared – and most
something companies could implement would agree that managing culture isn’t
easy. This is especially true for so-called
tacit knowledge (see table below) which
cannot be codified or stored. How that
knowledge is used and shared will
Tacit explicit knowledge
Some knowledge can be codified through a set of management and technological
procedures and put into repositories such as databases or presented on intranets.
Some, on the other hand, exists only in the heads of the employees or in the
relationships that exist between them.
Sidney Winter presents a classification of knowledge dimensions as a continuum
between the two sides of the table below.
Tacit Explicit
● not teachable ● articulable
● not articulated ● teachable
● not observable in use ● articulated
● complex ● observable in use
● an element of a system ● simple/independent
(Dimensions of knowledge assets, based on Winter, 1987)
Managing tacit knowledge is usually seen as the more difficult part but many
companies also struggle with explicit knowledge. A simple example is intranets,
which so many have got wrong. As an internal knowledge-sharing tool, their
potential is phenomenal, yet many intranets lie unused, with staff relying instead
on traditional ways of obtaining information such as social networks or using the
phone. This shows the importance of addressing cultural as well as structural issues
surrounding knowledge management.
19
Intellectual capital Knowledge management
depend on the unspoken norms of
behaviour that constitute organisational
culture. It is these, rather than formal
systems, that guide many employees’
interactions with customers, colleagues
and other stakeholders.
The way in which an organisation is
structured – its myriad formal and
informal relationships, the processes and
systems used, and the resources at its
disposal – will have a major influence on
its culture. This can constrain strategy
and goals and, consequently, the
organisation’s vision.
The elements of the globe expressed
in figure 9 combine to create an
organisation that is aligned to achieve
its vision which is, in turn, appropriate
for its marketplace and external
environment. The interconnectedness
serves to emphasise the importance of
looking outside as well as inside. You
may have a sophisticated knowledge-
management system, but if your
strategy is wide of the mark or you have
failed to assess your risks properly,
knowledge management by itself will
not give you a competitive advantage.
1 Knowledge process wheel
The knowledge process wheel, (see
figure 10) developed by Cranfield School
of Management’s Centre for Business
Performance, summarises a set of
knowledge management processes that
can be used to grow and maintain IC.
20
Figure 9: KPMG organisation system model
Marketplace
Vision
Strategy and
goals
Relationships Culture and
and structure values
Resources
Vision
Marketplace
Knowledge generation includes a
set of processes executed in order to
increase the stock of corporate
knowledge assets. There are two
main sub-processes of knowledge
generation: knowledge acquisition and
knowledge creation.
Knowledge acquisition is a process of
capturing and bringing knowledge from
the external environment into
the company. The simplest way of
doing this is to buy it, but knowledge
assets can also be rented (for example,
paying consultants to resolve specific
problems or building relationships
through alliances). Some companies,
known as knowledge brokers,
specialise in providing support for
knowledge acquisition.
Knowledge creation is the process of
developing new knowledge assets
within the company. As it’s linked to
individual learning processes, it can be
(M Jeans, 1998)
Processes and
systems
the result of either fortuitous individual
activity or planned organisational
policy. The most effective way of
creating knowledge internally is to
encourage employees to be creative and
keen to learn by devoting specific
resources to these processes. A common
way of doing this is to establish
units designed for this purpose, such as
R&D departments.
Knowledge mapping is the
process of identifying knowledge assets
within an organisation and defining
ways of accessing them. Enabling
everyone to access existing knowledge
makes it easier to create new
knowledge assets. Knowledge mapping

Figure 10: Knowledge process wheel
Knowledge
application
Knowledge
codification
Knowledge
Knowledge
generation
Knowledge
transfer
is usually supported by knowledge-
storing technologies.
Knowledge sharing is a process that
allows knowledge to be disseminated
across an organisation. Many companies
admit that “if they knew what they
knew” the benefits would be
considerable. There would be less
duplication of effort and information
used for decision-making would be
more accurate. The main obstacle to
knowledge sharing is that knowledge
often represents a source of power to
be guarded jealously. This is especially
true in economic downturns, when
having unique knowledge can make
you indispensable.
Knowledge sharing can be done
through either formal or informal
processes. The former includes
meetings, seminars and workshops,
knowledge databases or internal
documents. Informal processes
include casual discussions between
individuals. Companies should
encourage such knowledge sharing by
providing time, space and social
activities for this purpose.
Knowledge
storing
Knowledge
mapping
Knowledge
sharing
Sharing can also be supported by the
right IT infrastructure, such as on-line
databases, data warehouses/knowledge
repositories, intranets, decision-support
tools and shared drives. Companies that
have implemented these should
remember that their success depends on
people actually using them and that IT
can only ever be a facilitator or a tool
that brings scaleability to the process.
Knowledge transferring is the
process of passing on knowledge
between cognitive systems. A distinction
is often made between intra- and inter-
organisational knowledge transfer.
When it takes place within a firm,
among different units, groups or
individuals, it overlaps with knowledge
sharing. When it involves several
companies, it shares characteristics with
Intellectual capital
many knowledge-acquisition processes.
The main difference is the disparity of
use. The former is intended to turn
individual/team knowledge into
organisational knowledge. The latter
works towards creating a channel and a
context that enables an organisation to
acquire the knowledge from the outside.
Knowledge codification is the
process aimed at formalising knowledge
into appropriate codes such as words,
pictures or film. It involves:
● capturing knowledge – identifying
knowledge related to an activity
needed to achieve a specific
business goal;
● externalisation – changing the nature
of knowledge from a tacit to a more
explicit one;
● representation – a description of the
explicit knowledge with an
appropriate set of information codes.
Knowledge storing is the process of
saving knowledge within the
organisation, thus making it available
anywhere at any time. This process is at
the heart of knowledge mapping and
can take the form of either knowledge
databases or directories. In the former,
codified knowledge is stored in
appropriate information codes. This
method is used by many consultancies,
such as Accenture and Ernst & Young,
which have developed best-practice
databases to support their consultants
throughout the world.
Directories, on the other hand,
provide links to people with specific
know-how and the only information
stored is that required for identifying
people and places where knowledge
resides. For example, pharmaceutical
company Hoffman-LaRoche, as a part of
its overall drug approval process
knowledge map, has a catalogue of
21
Intellectual capital Knowledge management
relevant experts, arranged according to
know-how, questions and issues.
Knowledge application is the
process of applying knowledge within
the organisation. Knowledge becomes
a value-added resource only if it is
applied to improve business
performance. Translating knowledge
into action can mean a difference in
organisational performance.
Combining the classification of
knowledge assets within a company
with the analysis of appropriate
knowledge processes allows managers
to identify and understand the levers
they need to pull in order to manage
their companies’ capabilities.
Even if they are reluctant to instigate
a comprehensive knowledge-
management system, companies should
still consider how individual elements
may be applied. The knowledge process
wheel could be used to identify any
obvious gaps in their systems.
2 KM and the accounting
profession
The move to a knowledge-based
economy has had a direct effect on the
accountancy profession. Information once
represented power and accountants had
access to data that few others
understood or knew how to get hold of.
Advances in technology mean that
information is more widely available and
accessible, and much of routine
processing and analysis can now be left
to IT. There are also more people, such
as those with MBAs, who are trained to
22
understand and use financial
information. The importance of non-
financial information has also increased.
As for accountants’ skills, a recent
publication by FMAC (the Financial and
Management Accounting Committee of
the International Federation of
Accountants) says: “Local knowledge
and technical competence will be
insufficient; instead a premium will
be placed on value-adding contributions
to management.”
If they are to add value, in other
words, accountants will have to
combine the knowledge and
understanding of “traditional” financial
information within their control with
more sophisticated interpretation
techniques. This means ensuring they
develop greater commercial awareness,
including fostering better links with
other departments and appreciating
how their role contributes to the
strategic direction of their companies.
Accountants in business will increasingly
have to position themselves not as
number crunchers but as strategic
advisers who can help companies to
understand and evaluate their financial
and competitive position.
A recent CIMA-sponsored report,
“Management accounting and
knowledge management”, based on
workshops in 10 companies, concluded
that, while they were getting pretty
good at acquiring and sharing
information about competitors,
customers and suppliers, they often did
nothing with it. In each of the
workshops, participants found it much
harder to identify processes for retaining
and using knowledge than those for
acquiring and sharing it.
The report concluded that
management accountants should
contract rather than expand their view
of strategic management accounting
and that the onus should shift to
managing the knowledge resources
already held within the organisation.
Because their skills are based on
measurement and control, management
accountants are also best placed to
become the champions of cross-
functional knowledge-management
activities in organisations, possibly in
partnership with HR professionals.
The research also found that the
business case for knowledge
management tends to be obscured
because of a lack of understanding of
links between knowledge management
and financial results. Accountants’
involvement in this area could make the
interdependencies much more visible by
developing appropriate performance
management and reward systems. ■

5 Reporting intellectual capital
1 Accounting standards
Some intangibles are already included in
traditional financial statements. In fact,
the accounting rules for reporting
intangible assets have been evolving
over the past 20 years or so.
By the early 1990s, SSAP22
(Accounting for goodwill) and SSAP13
(Accounting for R&D) were well
established, but there were no specific
guidelines for dealing with items such as
brands, despite the fact that they
accounted for much of the market value
of some companies.
As a consequence, the Accounting
Standards Board introduced FRS10, the
main standard for reporting intangibles
and goodwill. It came into force for
accounting periods ending on or after
23 December 1998 and replaced
SSAP22. Intangibles are defined as
“non-financial fixed assets that do not
have physical substance but are
identifiable and controlled by the entity
through custody and legal rights”.
According to UK Gaap the objectives of
FRS10 are to ensure that:
● capitalised goodwill and intangible
assets are charged in the profit and
loss account in the periods in which
they are depleted;
● sufficient information is disclosed in
the financial statements to enable
users to determine the potential
impact of goodwill and intangible
assets on the financial position and
performance of the reporting entity.
In 2005, when the international
reporting standards are due to replace
national rules for companies listed on
regulated markets within the EU, IAS38
will supersede FRS10.
IAS38 grew out of an early attempt to
devise an accounting treatment for R&D
costs and was finalised in July 1999. Its
definition of intangible assets is similar
to that in FRS10, except it adds that
intangible assets are held for use “in the
production or supply of goods and
services, for rental to others or for
administrative purposes”.
IAS38 specifies that a company can
only recognise an asset if:
● it is identifiable;
● it is controlled;
● it is probable that future benefits
specifically attributable to the asset
will flow to the enterprise;
● its cost can be reliably measured.
These criteria apply to both purchased
and self-created assets. In fact, IAS38
does not specify that internally
generated intangibles can never be
recognised as assets. It is laid out in such
a way, however, that it is difficult to
imagine items meeting the recognition
criteria (see UK and international Gaap,
Tolley/Ernst & Young).
If the item does not meet the above
criteria, IAS38 requires the expenditure
on it to be recognised as expense when
it is incurred. This also applies to the
following items at all times:
● internally generated goodwill;
● start-up, pre-opening and
pre-operating costs;
● training costs;
● advertising costs;
● relocation costs.
Intellectual capital
According to the International
Accounting Standards website,
www.iasplus.com, examples of possible
assets as defined by IAS38 include:
● Computer software.
● Patents.
● Copyrights.
● Movies.
● Customer lists.
● Mortgage servicing rights.
● Licences.
● Import quotas.
● Franchises.
● Customer and supplier relationships.
● Marketing rights.
It is clear from this list that much of
what is commonly regarded as
intellectual capital would not in fact
pass the recognition test. The main
reason for this is that many intangibles
cannot be controlled. Both FRS10 and
IAS38 mention control as being central
to the definition of an asset. As the UK
and international Gaap says: “The
notion of maintaining custody over
something that has no physical
substance may seem rather strange
but FRS10 explains that it means such
things as keeping technical or
intellectual knowledge secret. The
requirement for this to be through
custody or legal rights means that
pseudo-assets, such as portfolios of
clients or a team of skilled staff, could
not be recognised as assets, as there is
insufficient control.”
IAS38 defines control as the ability to
obtain future economic benefits
23
Intellectual capital Reporting intellectual capital
generated by the resource and the
ability to deny those benefits to others.
This normally means legal rights, as in
FRS10, but control can also be
demonstrated “in the absence of legal
enforceability by factors such as market
and technical knowledge. However,
skilled staff, customer portfolios or
market share are unlikely to be
controlled in such a way to meet the
definition of intangible assets.”
Customer satisfaction is a case in
point. As Wayne Upton says in his 2001
Financial Accounting Standards Board
(FASB) paper, Business and Financial
Reporting, Challenges for the New
Economy : “While the entity may reap
economic benefits from happy
customers and workers, it cannot deny
others the ability to entice away
customers and employees. The control
criterion allows accountants and
others to draw boundaries around
particular things that may be
recognised as assets.”
He goes on to say that we should
consider the possibility that certain items
shouldn’t be included in financial
statements because they lack the
essential characteristics of assets, rather
than because the financial statements
cannot accommodate them. This is the
24
opposite of the now almost universal
view that financial reporting is out of
date and unable to cope with the
demands of the new economy.
Upton quotes a merchant banker who
says: “Balance sheets are for stuff, not
people or ideas. People aren’t assets
because you can’t own them, at least
not in this country (I’m neglecting
alimony here); you can only rent them.
Ideas are not assets because, partly due
to the fact that people who generate
them can’t be owned, you can’t keep
them bottled up for very long. If you
want to measure the value of people
and their ideas, you need to look at
cash flows, not assets. Balance sheets
measure the value of stuff you own,
cash flows measure the value of things
you rent.”
A similar argument is put forward in
Andrew Lennard’s essay for the
Accounting Standards Board (ASB),
Liabilities and how to account for them.
He says that it is impossible to imagine
how the true value of a company could
be calculated with a reasonable degree
of credibility and objectivity. Also, the
desire to approximate the total of the
balance sheet with the market value of
the company belies a misunderstanding
of the information needs of investors.
Analysts, for example, do not want to
be told what the value of a company is
– it is their job to work it out from the
financial statements and other sources.
In other words, information provided
in financial reporting is only the starting
point, a part of the bigger picture.
Investment decisions, as Lennard says,
are about what is going to happen in
the future, and financial statements can
only contribute to that understanding.
2 Operating and financial
review
Although it seems unlikely that many
intangibles will soon appear on financial
statements, the operating and financial
review (OFR) could be a suitable form
of narrative reporting for identifying
their importance.
The recent company law review, likely
to be included in the updated
Companies Act 2003, requires all public
and large private companies to produce
an OFR. Besides traditional financial
measures, the OFR requires companies
to include an account of how intangible
assets contribute to its overall value
generation and how the conflicting
stakeholder interests are balanced.
The key area to be covered from the
IC reporting point of view is the
“dynamics of the business” – in other
words, known trends, events,
uncertainties and other factors that
may substantially affect future
performance, including investment
programmes. The report specifies some
of the areas that companies may be
required to address – for example, risks
and opportunities and related responses
in connection with:
● competition and changes in
market conditions;
● customer/supplier dependencies;
● technological change;
● financial risks;
● health and safety;

● environmental costs and liabilities;
● projects and programmes to maintain
and enhance tangible and intellectual
capital, brands, R&D and training.
The ASB guidance on OFR published
in January this year says that it should
give a commentary on the strengths and
resources of the business that will help it
in the pursuit of its objectives and, in
particular, on those items that are not
reflected in the balance sheet. Such
items might include:
● corporate reputation and brand equity;
● intellectual capital;
● licences, patents, copyrights and
trademarks;
● R&D;
● customer/supplier relationships;
● proprietary business processes;
● websites and databases;
● market position/dominance.
The ASB adds: “The use of relevant
financial and non-financial measures will
often assist the user’s understanding of
the potential value of such items.
However, it is not intended that an
overall valuation of the business must be
given, nor, in the case of listed
companies, for net asset value to be
reconciled to market capitalisation.”
Some of the areas mentioned
correspond loosely to IC components. It
is questionable, however, how many
companies will complete their OFRs in
the spirit of the ASB guidance. A recent
report shows that the more innovative
disclosures in the ASB proposal – such as
the dynamics of the business, forward-
looking disclosures, revenue investment
and soft assets – are generally being
resisted by companies, including some
of the biggest (“Half the story”,
Association of Chartered Certified
Accountants, 2003).
The OFR is a “through the eyes of
management” statement which relies on
directors’ judgment of materiality. It may
therefore lack comparability, both
between companies/sectors and year on
year. There is also a danger that material
disclosed will be too vague and difficult
to understand. On the other hand, it is
precisely this judgment of what is
material for individual businesses that
could accommodate the idiosyncratic
nature of many intangibles. In any case,
whichever method companies choose to
adopt, it will need to have credibility
with the stock market.
3 Intellectual capital reports
If we accept that, for the time being,
intangibles are unlikely to appear in
published balance sheets, we are still left
with a problem of how to account for,
measure and manage what are
undoubtedly important value drivers in
many of today’s businesses. Investors
need this information if they are to
value companies with a greater degree
of accuracy.
Some research (Holland, 2002) points
to the fact that much of this information
does in fact get communicated, albeit in
private meetings between companies
and investors. Although this can
function relatively well, clearly it is not
an ideal situation for the investment
community as a whole, as it is biased
towards the big institutional investors.
Intellectual capital
In Europe, there have been various
initiatives to address the reporting of
intellectual capital, most notably the
Meritum guidelines and its follow-up
project E*Know Net (both sponsored by
the EU and the Organisation for
Economic Co-operation and
Development) and a Danish initiative on
intellectual capital statements sponsored
by the Danish government.
As a way of overcoming the
information imbalance, these research
projects suggest that companies start
publishing a supplement to the
annual report – a so-called intellectual
capital statement.
Based on best practices observed in
more than 100 European companies,
the projects have resulted in guidelines
on how to report intellectual capital.
Although the guidelines vary slightly in
content and terminology, the underlying
ideas are the same. Organisations are
encouraged to produce reports that
contain the following three elements:
● narratives about the company vision;
● management challenges and actions;
● a set of indicators.
The narratives give organisations the
space to explore their strategic
objectives, the products they sell and
their customer approach. It also
identifies the critical intangibles and
describes how they drive performance
and deliver value to stakeholders.
With management challenges and
actions, an organisation can explain
which IC assets need to be strengthened
or acquired in order to achieve its
strategic objectives. It allows firms to
report on activities, initiatives and
25
Intellectual capital Reporting intellectual capital
processes, either already in place or
planned for the future. Activities and
managerial actions can also be prioritised.
Organisations can create a set of
indicators that visualise their
performance in terms of intellectual
capital management. Users of
intellectual capital statements should be
able to look at these and assess how
well the company is fulfilling its
objectives. There is no predefined set of
measures and the set chosen can
include indicators that measure effects,
activities or the resource mix.
Many firms across Europe already
publish IC statements on a voluntary
basis. They see it as a way of increasing
transparency and explaining their view
of the company’s business model to
the market. But, while separate
intellectual capital statements may be
appealing to users of information,
especially individual shareholders, they
may place an unwelcome burden on
companies already facing greater
demands for transparency.
There is also a danger of information
overload – many companies already
produce corporate social responsibility
reports. At this stage, it is not yet clear
whether there will be a consensus
about the advantages of producing
these kinds of statements, or
whether such reporting will one day
become mandatory.
26
6 Conclusion
Intellectual capital is important to
both society and organisations. It can be
a source of competitive advantage for
businesses and stimulate innovation that
leads to wealth generation.
Technological revolutions, the rise to
pre-eminence of the knowledge-based
economy and the networked society
have all led to the realisation that
successful companies excel at
fostering creativity and perpetually
creating new knowledge.
Companies depend on being able to
measure, manage and develop this
knowledge. Management efforts
therefore have to focus on the
knowledge resources and their use.
Intangibles and how they contribute
to value creation have to be
appreciated so that the appropriate
decisions can be made to protect and
enhance them. There must also be a
credible way of reporting those
intangibles to the market to give the
investment community comprehensive
information to assist in valuing the
company more accurately
Huge investment flows in intangibles
do not appear as positive asset values
on financial statements, so the
traditional accounting model does
not represent them in a meaningful
format. But financial statements should
be seen as only a part of the jigsaw in
how companies assess and
communicate value. The finance
function has a key role to play in
managing knowlege assets and
understanding and communicating
sources of enterprise value. It may
take a while to reach a consensus on
what constitutes the best model for
managing and reporting intangible
value drivers. But experimentation is
invaluable if we are to agree on
best practice and arrive at a point
of convergence between the
disparate approaches. ■

References and further reading
A Profession Transforming: From Accounting
to Management, IFAC, 2001
“Assessing strategic knowledge assets in
eBusiness”, B Marr, G Schiuma and A Neely,
International Journal of Business Performance
Management, Vol 4 Nos 2-4, 2002
“Bridging the S-curve gap”, M Jeans, in
Success in Sight: Visioning, A Kakabadse
(ed), Thomson, 1998
Building Public Trust, S Dipiazza Jr and
R Eccles, John Wiley & Sons, New York, 2002
Business and Financial Reporting: Challenges
for the New Economy, W Upton, FASB, No
219-A, April 2001
“Creating a knowledge culture”,
S Hauschild, T Licht and W Stein, The
McKinsey Quarterly, No 1, 2001
“Efficiency through knowledge”, I Windle,
FT, 21/02/01
Financial Institutions and Corporate
Governance, J Holland, CIMA, 2002
“From the ancient Greeks to the modern
databases”, R Newing, FT survey –
Knowledge Management, 28/04/1999
Guidelines for Managing and Reporting on
Intangibles, Project Meritum, January 2002
Human Capital and Corporate Reputation,
ICAEW, June 2000
“How to measure an organisation’s
intellectual capital”, G Robinson and
B Kleiner, Managerial Auditing Journal,
Vol 11, No 8, 1996
“Intellectual capital: defining key
performance indicators for organisational
knowledge assets”, B Marr, G Schiuma and
A Neely, Business Process Management
Journal, Vol 10, No 4, 2003
Intellectual Capital – Issues and Practice,
ICAEW, June 2001
Intellectual Capital: Navigating the New
Business Landscape, G Roos et al,
Macmillan, London, 1997
“Knowlege and competence as a strategic
asset”, S Winter, The Competitive Challenge,
D Teece, Ballinger, Cambridge, 1987
Knowledge Management – A State of the
Art Guide, P Gamble and J Blackwell, Kogan
Page, 2001
“Known quantities”, B Marr, Financial
Management, CIMA, April 2003
Liabilities and How to Account for Them,
A Lennard, ASB, 2002
MA and Strategic Human Resource
Management, J Innes, R Kouhy and
R Vedd, CIMA, 2001
Management Accounting and Knowledge
Management, J Edwards, P Collier and
D Shaw, CIMA research report
Measurement and Management of
Intellectual Capital, IFAC, 1998
“Measuring and managing intellectual capital
and knowledge assets in new economy
organisations”, B Marr and G Schiuma, in
Handbook of Performance Measurement,
M Bourne (ed), Gee, London, 2001
“Measuring intellectual capital – the
internal and external drivers for measuring
and reporting intellectual capital,” B Marr,
D Gray, paper presented at “The transparent
enterprise, the value of intangibles”
conference, November 2002
Measuring the Immeasurable, A Wall, R Kirk
and G Martin, CIMA research report
“Measuring the worth of human capital”,
R Donkin, FT, 07/11/02
New Measures for the New Economy,
C Leadbetter, ICAEW, 2000
Non-executive directors’ survey 2002-03,
KPMG, 2003
“Performance evaluation in the new
economy”, International Journal of
Technology Management, Vol 16, Nos 1-3
“The knowledge tool box”, N Bontis et al,
European Management Journal, Vol 17,
No 4, 1999
Intellectual capital
“The metric system for performance”,
S Overell, FT report – Understanding Human
Capital, 31/10/02
“The next society”, P Drucker, The
Economist, 1/11/2001
The New CFO of the Future: Finance
Function in the 21st Century, Institute of
Chartered Accountants of Australia and
KPMG Consulting, 2001
The Performance Prism: The Scorecard
for Measuring and Managing Business
Success, A Neely, C Adams and M
Kennerley, Financial Times Prentice Hall,
London 2002
“Trying to grasp the intangible”, T Stewart,
Fortune, Vol 132, No 7, 1995
UK and International Gaap,
Tolley/Ernst&Young, 2001
“Value relevant information on corporate
intangibles”, J Holland, University of
Glasgow, paper presented at “The
transparent enterprise, the value of
intangibles” conference, November 2002
Valuing Intangibles, C Vance, ICAEW, 2001
Useful websites
CIMA
www.cimaglobal.com
Cranfield University Centre for Business
Performance
www.cranfield.ac.uk/som/cbp/
E*KNOW-NET
www.eu-know.net
International accounting standards
www.iasplus.com
Skandia
www.skandia.se/hem/hem.jsp
Ericsson
www.ericsson.com/cockpit/
Celemi
www.celemi.com
Ramboll
www.ramboll.dk/dan/default.asp
Bates Gruppen
www.bates.no/flash.html
Baruch Lev
http://pages.stern.nyu.edu/~blev/
Company law review
www.dti.gov.uk/cld/review.htm
Understanding corporate value: managing and reporting intellectual capital

The Chartered Institute of Management Accountants (CIMA) represents financial managers and accountants working in industry, commerce, not-for-profit
and public-sector organisations. Its key activities relate to business strategy, information strategy and financial strategy. CIMA is the voice of more than 77,000
students and 59,000 members in 154 countries. Its focus is to qualify students, to support both members and employers and to protect the public interest.
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Cranfield School of Management is a world-class university business school based in the UK. Renowned for its strong links with industry and business, it is
committed to providing practical management solutions through a range of activities, including postgraduate degree programmes, management development,
research and consultancy. The Centre for Business Performance is a research centre dedicated to performance measurement and management. The work of the
centre revolves around the design, implementation, operation and evolution of performance measurement systems. Its website is www.cranfield.ac.uk/som/cbp